John F. Kennedy once said, “When written in Chinese, the word ‘crisis’ is composed of two characters. One represents danger, and the other represents opportunity.” If one gets into the nuances of linguistics the above quote might be considered fallacious. However, it certainly carries some kernel of truth. The recent global financial crisis too resonated with what forms the essence of this quote. It undoubtedly represented danger to economies worldwide; but it also brought in its wake dramatic changes that can be viewed as opportunities.

One such change pertaining to the investment style of real estate investors shows a gradual change in attitude from optimism to prudence. Earlier, whenever investors were looking at the real estate market they placed greater stress on trading values derived from inflated rents, exaggerated future cash flows and a positive outlook in general. In the present-day, each deal is examined with a far more prudent outlook. However, to simply state that all investors pre-crisis were optimistic would be a massive generalisation. Seasoned investors in the property market have always taken a well-planned approach and adopted specific investment styles that are applicable globally pre or post crisis.

Investment in core properties is a very basic investment style wherein investors acquire relatively low-risk properties that are at least three- quarters leased to tenants who hold a good credit record. Their goal eventually is to receive a stable cash flow with competitive returns to comparable properties. Moving on, contrarian investing is based on the premise that the investment outlook for a specific property type would be poor amongst other investors. For instance, investors might form the opinion that online shopping would have a negative impact on retail properties. In such a case, a contrarian would wait until these specific types of properties become available at relatively lower prices and would then invest in them with the expectation that prices would move upwards going forward.

Investment in ‘blue chip’ properties is another investment style adopted by those investors who consider only those properties that have some unique attributes – architectural, locational or otherwise. These properties are highly visible and well-located and are looked upon as lucrative investments for the long term. Opportunistic investing is one wherein an investor acquires properties from other investors who are currently in financial distress and/or the property in question needs an upgrade or some form of renovation. However, opportunistic investment is tricky in the sense that the success of the investment is directly dependent on the investor’s ability to purchase the property at a discount as well as the management’s understanding on how to provide an overhaul or reposition the property. Such investments also need a carefully planned exit strategy.

Besides these, there are a host of other investment styles adopted by seasoned investors and portfolio managers. What works for one type of investor, might not necessarily work well for another. Many of these strategies overlap and in essence they are all means to an end – the end being realisation of superior investment performance.

About the author
Ankita Satnaliwala is the Senior Analyst, Research and Real Estate Intelligence Service for Jones Lang LaSalle in India, based in Kolkata.

Reports from the world of physics suggest that scientists are closing in on the Higgs boson. This sub-atomic particle is apparently the key to unlocking the deepest secrets of the universe, but until now it has evaded detection. Scientists at the CERN facility in Switzerland are, according to recent reports, ramping up their search for the boson.

Real estate analysis faces a similar challenge. Recently the Royal Institute of Charted Surveyors (RICS) held a two-day seminar in Adelaide on the subject of real options, attended by distinguished academics from the US, Singapore, China, New Zealand and, of course, Australia., as well as a few practitioners from the real world.

Real options are the rights that owners, investors … tenants…everybody in fact…have to exercise choice. In the real estate world obvious examples are options to renew or extend leases, to build or to demolish a property. As attendees at the RICS seminar learned, turnover rents in shopping centres can be modeled as real options. As a building gets older, it loses value from a future cash flow perspective, but gains optionality value.

In the world of finance, optionality value is most obviously on display when predators pay a big premium to take over a company. The right to control a company confers real optionality value on the majority shareholders. They can make decisions and implement them. Minority shareholders have no such rights.

But there is a conundrum…

If optionality is so pervasive, like dark matter in the world of cosmology, then where is it? After all, investors assess the market value of assets all the time. They conduct detailed analysis of the cash flows. They apply a discount rate. They capitalise the rents after a decent interval, say ten years. And they calculate the value.

But where is the optionality value?

There are two possibilities:

1) Either the standard valuation ignores optionality, in which case all valuations are understatements of actual market value (which seems an incredible proposition), or, more likely:

2) Those valuations incorporate optionality value but it is embedded somewhere in the DCF (discounted cash flow) valuation: just like the Higgs boson is out there, somewhere.

But, of course, if optionality is embedded in the discounted cash flow (DCF) calculation this means that either the cash flows or (more likely) the discount rates are biased. Perhaps all discount rates are too high? And perhaps this doesn’t matter too much. If you could extract optionality value as a separate constituent of value, the higher discount rate would be exactly offset by the additional optionality value. This seemed to be the broad, if tentative, conclusion from an interesting discussion at the RICS seminar in Adelaide.

DCF calculations were controversial when they were first introduced. Option pricing is at a similar stage now. The RICS seminar was only the opening broadside. Expect to hear more about real options in the future.

About the author
David Rees is the Head of Research for Jones Lang LaSalle in Australasia, based in Australia.